The Monetary Transmission Mechanism in Pre-war China

Abstract: When the international monetary system was on the gold standard, China was the only country adhered to the silver standard. Silver functioned as currency in China but acted as commodity in international markets. Its price experienced downturn trend from 57 cents per ounce in January 1929 to 23.38 ounces per ounce in January 1933. Then it increased to 75 cents per ounce in May 1935. Dramatic fluctuations in silver price seriously impacted Chinese economy. On the initial stage of the Great Depression, devaluated silver price led to currency depreciation which brought “good luck” to China. However, as Britain going off the gold standard in 1931 together with massively scale of countries giving up gold currencies, competitive currency depreciation stimulated silver to regain its price, which dampened Chinese domestic industries and facilitated an increase in silver exports. China’s wholesale price index decreased from 114.78 to 99 and its monetary system endured awful shocks which directly led to governmental currency reform in November 1935. The main contribution in the paper is to figure out the monetary transmission mechanism in pre-war China. Based on the testing results of Spearman rank-order correlation and Structural VAR model, a conclusion was drawn that exchange channel worked more significantly in the first period while monetary channel performed better in the second period. Historical analysis is conducted to further verify the conclusion.